BHP Billiton will not use demerger cash for acquisitions, says Andrew Mackenzie

Amanda Saunders

Despite BHP Billiton’s controversial $US15 billion ($16 billion) spin-off freeing up cash flow for the mining company, chief executive Andrew Mackenzie says acquisitions are not on the cards and the miner will instead concentrate on executing the cheapest possible expansions of its ''four pillar'' commodities.

In contrast, the new resources group, to be based in Perth and dubbed ''Newco'', will have to look to acquisitions to drive growth and will hold minimal debt.

Mr Mackenzie has told analysts to ''assume mergers and acquisitions is off the agenda for a considerable period''.

Rather, a nimbler, simpler BHP would look to invest in expanding its four pillar commodities of iron ore, petroleum, ­copper and coal. Potash is a possible fifth pillar.

''We’ve announced a very low cost expansion of our iron ore operations ... [which is] hugely value-increasing to shareholders, and I would argue that those sorts of possibilities are only going to increase in their probability, as a result of this transaction [the demerger],'' Mr Mackenzie said.

BHP unveiled on Tuesday plans to ramp up iron ore capacity by 65 million tonnes a year to 290 million tonnes, at a capital cost of under $50 a tonne.

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Credit Suisse analyst Paul McTaggart says it was increasingly important to have good options outside iron ore to invest in, given the aggressive increase in production by the iron ore majors and a poor price outlook for the commodity.

The new company fills a huge void in the Australian market, ''as a beast that has exposure to improving commodity prices'', he said.

''It’s not a growth asset, it’s a cyclical play on commodity prices, and that’s fine, there’s a place for that,'' he said.

''We’ve been missing a decent mid-cap mining house to invest in for a while in Australia. I don’t know any Australian investors that are anti it.

''The new group will fill a nice niche, where if you want to take a broad view on non-iron ore commodity prices, you’ve got a liquid vehicle with some market cap, that you can buy. That’s a good thing for the market.''

BHP opted against offloading debt into Newco, to ensure it started life with a robust balance sheet. Macquarie Group analyst Adrian Wood said the spin-off could assume about $US1.7 billion in debt and still achieve BHP”s stated aim of an investment-grade credit rating.

The miner’s decision on debt surprised many analysts, who had figured BHP would shunt $US1 billion to $US2 billion in debt into the new vehicle to free itself up to run a buyback.

Mr McTaggart stressed that the spin-off represented just 8 per cent of BHP’s asset base and was ''not that big a deal, in fact it’s a distraction in many ways''.

BHP – like Rio Tinto – had limited earnings growth potential, because forecast declines in iron ore would offset big production increases and cost-cutting, he said.

Mr Mackenzie’s focus on cuts saw BHP beat its cost-cutting target by $US1.1 billion to clock $US2.9 billion in in financial year 2014 , bringing the grand total to $US6,6 billion.

The miner also revealed it was targeting another $US3.5 billion in cuts over the next three years.

The miner shaved almost $US4 a tonne from its all-important unit costs in iron ore, from $US29.30 a tonne to $US25.80 a tonne. Deutsche Bank tips the rate will fall to $US24 a tonne in the next few years.

Mr McTaggart said aggressive iron ore expansions by the majors added further cause to invest in cyclical plays outside of the commodity.

''BHP is saying they get to 290 (mtpa) quite quickly, you’ve got Rio that is going to sit there at the end of next year at a capacity of 360 (mtpa) but they can ramp that more quickly,'' he said.

''There is a bit of a question for the iron ore markets that comes with having these two big monsters. You might actually want to own something that is not exposed to iron ore.''

Some London investors see the spin-off as a shrewd move by BHP to rid itself of mistakes of the past, but Mr McTaggart disagreed.

''We all knew at the time (2001) that the Billiton merger was a disaster,'' he said. ''We know that the merger ratio historically was always wrong, that’s obvious, but I’m not so cynical as to say this is a way to hide the stuff-ups of the past.

''The new company will be able to do its own thing, to reinvest, because it’s been starved of capital, and everyone is probably better off.''

The market was expecting a buyback to be unveiled with BHP’s results on Tuesday, with analysts tipping a rolling on-market program of at least $3 billion.

BHP’s underlying profit for the full year of $US13.4 billion also came in lower than expected.

''This demerger has no impact on what capital management program we plan to do,'' Mr Mackenzie said.

''We’ve no decision about when we start, other than that it will be consistent and predictive over a period of years.

''We are not quite ready ... but our balance sheet is getting stronger.''

The $US15 billion spin-off, to be based in Perth, will be distributed to all BHP shareholders. It will take a primary listing on the ASX and a secondary listing in South Africa.

A target listing date has been set for mid-next year, subject to a shareholder vote.